It Won’t Be Easy to Replace Mario Draghi

(Bloomberg Businessweek) -- If you’re looking for the world’s hardest job, then search no farther than Frankfurt.

The president of the European Central Bank must oversee an institution that sets monetary policy for a currency area with 19 member states. Since 2014 the ECB has also been the main banking supervisor for the monetary union, with duties that include demanding capital increases for lenders and closing down failing institutions from Italy to Latvia. Finally, the central bank is deeply involved in the riotous debates over the future of the euro zone; it has struggled to suggest a way forward that will accommodate the conflicting views of national authorities and politicians. All the while, every word emanating from the office is followed closely for clues to policy directions.

The president has to do more than watch his words. Mario Draghi, who’ll step down at the end of October after an eight-year-term, was scrutinized for the color of the ties he wore at his regular press conference, which some observers half-jokingly speculated could signal the ECB’s monetary stance. One analyst—Louis Harreau of Crédit Agricole Group—actually ran the numbers on 18 ties the president wore through scores of speeches to try to find correlations between cravat and credit. His conclusion, tongue firmly in cheek: There weren’t any. He did note the slight possibility that blue ties were associated with market movements—but both up and down, meaning the factor couldn’t be priced into anything.

Fashion judgments aside, the 71-year-old Italian has taken a hard job and made it look like an easy fit. Formulated with both bravado and financial acumen, his pronouncements have mattered—and changed the course of history. His pledge to do “whatever it takes” to preserve the euro is widely credited with rescuing the single currency during the 2011-12 sovereign debt crisis. He also oversaw the expansion of the ECB into the realm of banking supervision, making it the most powerful European institution at a time when other bodies, including the European Commission, have lost their influence over national governments.

But European leaders must now find a suitable replacement, who’ll become only the fourth ECB president. (Wim Duisenberg of the Netherlands and Jean-Claude Trichet of France preceded Draghi.) The contenders include Jens Weidmann, president of the Bundesbank, François Villeroy de Galhau, governor of the Banque de France, and a string of candidates from countries ranging from the Netherlands to Finland. Europe isn’t short of central banking talent, but none of the prospects quite matches the charisma and the abilities of the current chief. The daunting question facing the euro zone is whether a more ordinary president can be strong enough to hold together the fractious monetary union.

Draghi came to the job with exemplary experience in academia, the public sector, and banking. He obtained a Ph.D. in economics in 1977 at the Massachusetts Institute of Technology, under the supervision of Franco Modigliani and Robert Solow, both of whom went on to win Nobel Prizes in economics. A professor at the University of Florence, he became director general of the Italian Treasury before joining Goldman Sachs Group Inc.. In 2005 he was picked to be governor of the Bank of Italy; he took the helm at the ECB in 2011, just as the euro zone was being buffeted by the sovereign debt crisis.

Draghi had some luck when the time came to steer the monetary union out of that sea of turmoil, which threatened its very existence. The U.S. Federal Reserve, under Ben Bernanke, a scholar of the Great Depression, had pioneered the use of unconventional monetary policies, in particular deploying large-scale asset purchases, also known as quantitative easing, to encourage investment and spending. Draghi immediately understood that the ECB also had to expand its toolkit. In 2012 he unveiled Outright Monetary Transactions, a pledge to purchase unlimited quantities of bonds from a country in crisis, provided it signed up to a rescue program. In 2015, when the euro zone was on the edge of a Japan-style deflationary spiral, the ECB copied the Fed and launched QE. These moves came late, unnecessarily delaying the euro zone recovery, but Draghi deserves enormous credit for pushing them through.

His ability to do so hinged on other skills. First, his dexterity with public messaging. OMT is probably the best bluff in monetary history: The ECB has never had to use the program, but its very existence reassures investors and prevents them from abandoning government bonds. Not only did this pledge almost single-handedly end the euro zone debt crisis, it also helped to avoid a new one when, in 2018, a populist government in Italy unveiled a package of spending measures that threatened Rome’s fiscal sustainability. Italian bond yields shot up, but—unlike in the 2011-12 period—there was very little contagion to other countries. Investors have chosen to believe in OMT despite its obvious faults: It remains untested, and it depends on a country signing up for a program of fiscal austerity and structural reforms—which is by no means a certainty.

None of this would have been possible had Draghi failed to carry European leaders with him. OMT and QE have been credible because they have broad political support. In particular, Draghi has displayed remarkable skill in maintaining the support of Germany. The German political and financial establishment has long been skeptical of bond-buying schemes, fearing they may amount to monetary financing of government deficits, which is explicitly forbidden in the Treaties of the European Union. Indeed, the Bundesbank has opposed many of Draghi’s innovations. Still, he’s used his political and communication skills to win Chancellor Angela Merkel’s support and relegate Bundesbank opposition to the stance of an outlier.

The departing president’s record has been by no means impeccable. Growth in the euro zone has slowed, calling into question the ECB’s decision to stop QE at the end of 2018. His management of the institution’s bureaucracy has also been lacking: This is evident at the Supervisory Board, the body that oversees the euro zone’s largest banks. At one stage in early 2019, four of the six board seats the ECB gets to propose or appoint were vacant, making the job of Andrea Enria, the new chair, more difficult.

But few doubt Draghi will be a very tough act to follow. It doesn’t help that two of his closest allies on the six-member executive board, Peter Praet of Belgium and Benoît Coeuré of France, are also stepping down this year. The ECB will have to replace half of its top monetary team in less than a year—all while the economy is slowing.

Olli Rehn and Erkki Liikanen, respectively the current and former governors of the Bank of Finland, who are widely considered front-runners in the race to succeed Draghi, aren’t academic economists by training; both have served as members of the Finnish parliament and as government ministers. Of course, there are examples of other central bankers without doctorates in economics, starting with Jay Powell, the lawyer who runs the U.S. Fed. But there’s a question of whether such figures can act with the intellectual confidence and speed of Bernanke and Draghi when they face a crisis. The ECB has in Irishman Philip Lane, its new chief economist, a powerful monetary brain. But the board is also becoming more overtly political: Luis de Guindos, the new ECB vice-president, is a former banker but was until recently the economy minister of Spain, which he helped to steer out of the euro zone crisis. Were there more such appointments, one could fear for the central bank’s independence—something Draghi warned about with regard to attempts to influence the U.S. Fed.

As a monetary scholar himself, Weidmann, president of the Bundesbank, has greater competence in economics than most of the candidates. But there are legitimate fears that, should he be selected as successor, the toolkit Draghi developed would immediately lose credibility. Weidmann opposed the OMT program, a vote which could make investors doubt that he’d be willing to do “whatever it takes” to save the euro. The Bundesbank chief has also been a long-standing critic of QE—an instrument investors believe the ECB could reactivate if the euro zone falls into a new recession. The election of a hawk during a slowdown could be particularly problematic: Investors may fear the ECB has run out of instruments to boost inflation, which could bring the monetary union back to the brink of deflation.

Klaas Knot, governor of the Dutch central bank, Villeroy de Galhau, and Coeuré are the other leading candidates. Knot earned his Ph.D. in economics from the University of Groningen, while Coeuré and Villeroy have had long careers at the French Treasury. But it’s less clear that they’d have Draghi’s political clout. Overall, Coeuré is probably the best available candidate, but he faces formidable political hurdles at home. In 2015, he was overlooked for the job of the governor of the Banque de France, with the government picking Villeroy de Galhau instead. French President Emmanuel Macron may also be more interested in pushing for one of his countrymen to be president of the European Commission—if so, he can’t be seen wanting the ECB post for France as well. Finally, there could be a rules problem: The eight-year terms of ECB executive board members such as Coeuré are not renewable.

Ultimately, Draghi’s successor will emerge out of a complex round of horse-trading, involving all the other jobs that become available this year. Apart from the leadership of the commission, these include the presidencies of the European Parliament and the European Council. The risk is that these negotiations will lead to a candidate chosen mainly to fit well with the other pieces of the jigsaw. Politicians may also be tempted to choose a feeble ECB chief, in the hope that he or she will be more easily swayed by political pressure.

That would be disastrous. The ECB has been effective under Draghi because it’s been able to act on a level above petty national politics—and indeed to promote the European project. Since the sovereign debt crisis, the euro zone has taken significant steps toward further integration. Along with centralizing banking supervision, it’s created a single rulebook and common pots of money to deal with banking crises. It’s also set up a much bigger rescue fund, the European Stability Mechanism, to help countries in trouble.

The process has much further to go. The euro zone lacks a centralized treasury that can help member states face an isolated shock without resorting to the stringent measures and conditions the ESM would impose. There’s also insufficient solidarity when it comes to taxation and spending decisions: For example, in the past few years, Germany and the Netherlands have run tighter-than-necessary fiscal policies, which have prevented them from helping other member states. All of this puts an enormous burden on the ECB, often the sole provider of short-term economic stimulus, particularly for countries with high levels of debt and poor market credibility.

Draghi is rightly criticized for his shortcomings. But he was exceptional at doing the hardest job in the world. When he goes, the frailties of the euro zone may well reemerge.

To contact the editor responsible for this story: Howard Chua-Eoan at hchuaeoan@bloomberg.net

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